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Diamond Foods in the Rough

Reports on Thursday are suggesting that two of the five largest shareholders of Diamond Foods (NASDAQ: DMND) have dumped the majority of their stake as ongoing accounting probes threaten to put a stop to the company's planned purchase of Pringles from Procter & Gamble (NYSE: PG).

The trouble seems to be stemming from accusations that DMND paid money to walnut growers, and the transactions violated accounting rules.

CEO Michael Mendes is at the forefront of the investigation. Mendes has successfully transformed Diamond from a walnut cooperative to a $1 billion business with snacks like Kettle chips and Pop Secret popcorn in its arsenal. Pringles was to be the cherry on a very sweet cake, but the deal looks like it is in serious danger.

Once you pop, you can't stop. But you do have to be careful when conducting business with walnut growers, apparently.

According to the Wall Street Journal, shares in Diamond have declined by two thirds since late September, an astounding loss. That decline does not look ike slowing down while the Securities and Exchange Commission continues its investigation.

So the question is, what the hell kind of payment could Diamond have given to walnut farmers that would cause this amount of trouble? We are talking about walnuts, not oil. Seriously, the walnut is perhaps the least offensive of all snack food items. They taste good in carrot cake, but is it not an uglier pecan?

Unconfirmed reports suggest that the payment was to top off growers who were underpaid the previous year. That seems weird – isn't it ok to pay off debts? But it is plausible because there are some weird rules out there regarding accounting practices.

If this is the payment in question, then that payment would belong in the 2011, reducing Diamond's annual profit to $1.14 a share rather than $2.61. In other words, the SEC is concerned that Diamond held out on a payment to make the books look better.

All of this, as mentioned, is unconfirmed. But it does seem to add up that, were those figures correct, Diamond is a lot less attractive and is in a far more precarious position. To buy a giant brand like Pringles, one has to be sure-footed. The slip could be devastating.

ACTION ITEMS:

Bullish:Traders who believe that Diamond will get Pringles and rise might want to consider the following trades:

Diamond with Pringles would be a giant. Watch it go.

Procter & Gamble might well invest that money wisely. It has a history of doing so.

Bearish:Traders who believe that Diamond will fall away following the investigation may consider alternative positions:

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